Cub Energy is extremely unhappy with amendments to the Tax Code of Ukraine concerning gas royalties

When we last wrote about TSX-Venture listed Cub Energy in the middle of November last year we reported that Cub Chairman and CEO Mikhail Afendikov said the company intended to keep “truckin” on in Ukraine, where it is focused, despite concerns about continued operations in that troubled country.

At that point the latest drilling report held good news in that on the 100 per cent owned Rusko Komarovske field, which is in Western Ukraine, the RK-23 well came in positively. The shallow L Sands in the (RK-23) well tested gas at a rate of over 2.3million cubic feet per day (mmcf/d) through an eight millimetre choke.

The results were included in the 3rd Qtr Results. With them in, the company said that production at the end of the third quarter September 30 had averaged 2,174 barrels of oil equivalent a day (boepd) for the three months (95 per cent natural gas). This meant an increase of 44 per cent over the 1,513 boepd in the same period of 2013.

Another good feature of the third quarter is that field operations at the 30 per cent owned KUB-Gas fields re-commenced with the spudding of the M22 well. This well is in eastern Ukraine where the political unrest has been most pronounced and was off limits to Cub for a while.

We now have just had the results of this well and they, like those for the RK well, were positive. The company has reported the exploration well reached a depth of 3,629 metres and has encountered gas in six zones. Two of those zones appear to be net pay with the other four having resource potential. Casing has been run and cemented, and the operator, KUB-Gas is now preparing to complete, test and tie in the well. This well could add materially to group output and show through in the fourth quarter totals. This is the good news.

The not so good news, and possibly very bad news, is the announcement of changes to the tax code of Ukraine concerning gas. Mikhail Afendikov has had made it clear in the past of his extreme unhappiness with the royalty situation. The temporary increase in royalty rates to 55 per cent impacted on net backs.

The netback of US$29.64/boe or US$4.49 /mcfe for the quarter ended September 30 2014, decreased as a result of the temporary increase in royalty rates. The netbacks compared with US$41.46/boe or US$6.91/mcfe for the quarter end June 30 2014.The temporary royalty hike could translate into a 50 per cent reduction in netbacks for Cub. In the past Afendikov has said: “The recent temporary actions by the Ukraine authorities to increase royalty rates caused the company to raise significant doubt about its ability to continue as a going concern and meet its obligations as they become due.”

Now the situation has worsened in insofar as the Ukraine parliament brought in new amendments to the tax regime. The company has said: “The government set the royalty rate at 55 per cent for production at or above depth of 5,000 metres. Wells producing at depths of more than 5000 metres are subject to a 28 per cent royalty rate.

“This royalty rate was first introduced as an emergency temporary measure effective August 1 2014 and was said to expire at the end of 2014. However, the recent Tax Code amendments made those changes permanent, effective January 1, 2015.

“Presumably, the discounted coefficient 55 per cent (effectively 30.25 per cent) for new wells has been eliminated because the amended law does not address it. The company will be seeking clarification on this and other aspects of the administration of the new amendments on an expedite basis”.

Afendikov said: “We are united with other private producers in Ukraine, as well as the American Chamber of Commerce, the European business council and other international business leaders to persuade Ukraine’s Parliament to reverse its actions. In the meantime, we are preserving our capital options given that this recent legislation will continue to result in lower netbacks and cash flow.